Washington, DC: On June 18, 2021, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Hungary and approved the staff appraisal without a meeting.[1]

The economy has been hit hard by the pandemic. GDP fell by 5% in 2020. Average inflation was 3.3% but, with continued strong wage growth, core inflation was 4.1% (old definition), just above the central bank’s tolerance band (MNB). Partly thanks to the support measures, the unemployment rate rose only modestly to 4.1%, remaining the lowest in the region. Tourist flows fell sharply and exports declined, but this was offset by lower imports and remittances from large multinationals. As a result, the current account remained broadly balanced in 2020. The budget deficit reached an all-time high of 8.1% of GDP due to tax deferrals and increased spending. The pillows of the banking sector remained, on average, comfortable. While Hungary has been among the countries with the highest COVID-related death rates, vaccination has been faster than the EU average.

After the first quarter results, a strong recovery is expected to take hold in 2021. Growth is expected to be around 6%, driven by net exports, as external demand improves and consumption picks up sustained through budget spending, private wages still growing rapidly and the accumulation of household savings. Headline inflation is expected to rise temporarily in the short term before falling back to 3½%, while unemployment is expected to gradually return to levels close to pre-crisis levels. Yet the uncertainty remains significant.

Board assessment[2]

In concluding the Article IV consultation with Hungary, Directors approved the staff assessment as follows:

The authorities’ political response to the crisis has been strong enough. The fiscal policy response has been substantial and timely. As a result, the deficit increased to 8.1% of GDP and public debt exceeded 80% of GDP. The MNB responded quickly to market pressures by providing abundant liquidity through a variety of policy tools. Like other EU banking regulators, the MNB has authorized a temporary relaxation and postponement of certain capital requirements and taken other micro and macroprudential measures.

Fiscal policy must flexibly balance support for the economy with maintaining medium-term sustainability. The continued and significant economic support enshrined in the revised budgets for 2021 and 2022 seemed justified in their preparation, given the significant uncertainty, the severity of the third wave of the pandemic and the need to avoid abrupt adjustments. that could jeopardize the recovery. However, as growth prospects have improved, buffers can be replenished more quickly by saving the windfall from higher incomes and possibly under-spending if less support is needed to anchor the recovery. Conversely, a decline in the recovery may justify additional support for households and businesses. In view of the high gross financing needs, the debt management policy should continue to aim to extend the maturity of the public debt. Given the scale of budgetary outlays, transparency in the use of public funds is crucial.

Minimizing the scars of the crisis and enabling economic transformation should be priorities for the future. Targeted support for viable businesses, especially SMEs, can help support these goals, as well as strengthening social safety nets and investments in infrastructure and human capital. Fiscal space can be created by continuing to increase revenue and reduce current expenditure, for example by further reducing the public wage bill as a percentage of GDP through rationalization of public employment. While efforts should be made to further improve tax collection and reduce exemptions and preferential regimes, the recent reintroduction of a temporary low preferential rate of VAT on new home purchases should be reconsidered. In addition, it would be preferable to increase the participation in the labor market of young people under 25 by means other than the general exemption from income tax provided.

The response of monetary policy to the crisis has been appropriate. Going forward, monetary policy should continue to be data driven to ensure that inflation stays within the target range, as risks are now mostly on the upside. Some overshoot of the inflation range due to temporary shocks is acceptable. Looking ahead, at this point, a simple tightening of monetary conditions will not be necessary as long as inflation expectations remain firmly anchored, but upside risks to inflation will need to be watched closely. Conversely, monetary policy may need to be relaxed further if the recovery falters. So far, the adaptation of monetary instruments has effectively provided the necessary liquidity and corrected market failures. As conditions normalize, MNB should continue to examine the effectiveness and necessity of its unconventional tools and consider reducing its ever-growing PPP.

Prudential policies should continue to focus on mitigating immediate vulnerabilities. As the recovery takes hold, the withdrawal of support measures will need to be gradual. The overall banking system cushions are comfortable, but continued prudential vigilance is warranted. Recent measures to strengthen the framework for combating money laundering are welcome.

The structural reform agenda is expected to facilitate the transformation to a more resilient economy after the pandemic. In the medium term, some pre-existing trends in the global economy have been accelerated by the pandemic and are likely to require economic transformation and workforce retraining. The recently proposed revisions to the bankruptcy framework aim to support a more orderly and efficient restructuring of companies. The reallocation of the workforce between sectors must be supported by a strengthened social safety net, including unemployment benefits, and greater investment in human capital, including health care and (re ) lifelong learning, as expenditure in these categories is lower than the EU average.

Greening the economy, to which the authorities are strongly committed, is necessary for sustainable growth and must be supported by higher carbon pricing. Hungary aims to achieve climate neutrality by 2050, relying on renewable and nuclear energy production, recycling and energy conservation. Higher carbon pricing would promote energy efficiency and innovation and bring revenues that could help finance green investments and compensate the most vulnerable users for higher energy costs. Given the evolving EU framework, it may be preferable at this stage to encourage green investment through transparent tax subsidies, also applying to self-financed and credit-financed investments, rather than prudential measures.

EU recovery and resilience funds can help leverage authorities’ efforts. The swift implementation of reforms, within the framework of strengthened competition, governance and transparency frameworks, is essential to put the post-crisis economy on a more sustainable and resilient path.